almost 3 years ago • 4 mins
From copper to corn, commodity prices have rallied massively in 2021. And with the recovery now putting stocks at risk, there could be a lot more upside to come for the long-time underdog.
Back in 2008, commodity prices were six times higher than those of global stocks. In the decade since, though, they’ve been trounced by stocks. And now, despite their recent rally, they’re trading at 50% less – the biggest discount on record.
Still, there are a couple of good reasons to think the recovery will allow commodities to not just close that gap, but actually overtake stocks after more than a decade of lagging behind.
While the probability that inflation will get out of control is still relatively low, it keeps increasing. And for consumers, high inflation would rob them of their purchasing power and keep them from spending as much as normal. For companies, meanwhile, the higher cost of raw materials would squeeze their margins. Neither’s good news for stock prices.
But the biggest threat to stocks is that a spike in inflation might force central banks to raise rates, which would push up the cost of borrowing for companies and reduce the value of their future cash flows. In other words, they’d be worth less and their share prices would, in turn, drop. In fact, the recent underperformance of tech stocks – which are more sensitive to higher interest rates – shows this drop-off might already be under way.
It’s a different story for commodities, which tend to thrive in an inflationary environment. High inflation is a symptom of demand exceeding supply, which leads companies to bump up their production – and their raw material orders – to meet the need. So commodities benefit from stronger economic growth just like stocks do, but they have the advantage of benefiting from the inflationary pressures of a rapidly growing economy too.
It’s no secret that stocks are trading at expensive valuation levels, but arguably the only factor that justifies such high valuations is how low interest rates are. And since inflation might do away with that key support, stocks could be exposed to some significant downside risks.
Commodities’ fundamentals, on the other hand, are really strong. Governments’ massive stimulus programs – which include significant investments in infrastructure – are driving unprecedented demand for raw materials. And that strong demand isn’t just coming from one major economy like China: everywhere around the world is looking to make significant infrastructural improvements following the pandemic.
That demand is being exacerbated by governments’ focus on supporting lower-income households too, which tend to spend more money on commodity-dependent goods. Put together, these factors should send demand for commodities to levels last seen in the mid-2000s.
Better yet, the supply can’t catch up quickly enough to meet that higher demand, with supply chains running low and most commodities markets in deficit. Decades of low commodity prices, after all, have seen commodity producers invest less and less into production, and it takes months – if not years – to bring new supply to the market, making a sudden surge in demand difficult to meet.
There you have it: commodities are heading into the recovery in a unique position, and they could be a great way to add some juice to your returns. So if you’re looking to rotate some of your stock exposure to commodities, there are a couple of ways you could do it.
For European investors, the L&G All Commodities UCITS ETF is a good bet: it tracks the Bloomberg Commodity Index and provides you with a diversified exposure to energy, precious metals, industrial metals, livestocks, grains, and soft commodities. The extremely low expense ratio of 0.16% arguably makes it the most efficient way to back commodities.
For US investors, there’s the widely popular Invesco DB Commodity Index Tracking Fund (Ticker: DBC). But I’d highlight two lesser-known opportunities: the iShares Bloomberg Roll Select Commodity Strategy ETF (Ticker: CMDY), and the Aberdeen Standard Bloomberg All Commodity Strategy K-1 Free ETF (Ticker: BCI). They’re not only among the cheapest options, but they also offer interesting extra features, like reducing the costs of rolling futures and not requiring K-1 filing.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.